Despite this immense market size, the industry still faces multiple challenges and inefficiencies when purchasing, leasing, managing and analyzing real estate assets.
Generally speaking, real estate transactions involve several ecosystem actors such as owners, tenants, operators, lenders, investors, and service providers all of which require access to trusted information alongside the ability to update or modify that data. Each of these entities creates additional layers of friction as there is no common shared database where the integrity and accuracy of the data can be trusted. Moreover, these entities may lack trust among each other as participants are interacting for the first time (think leasing an apartment).
With these challenges in mind, blockchain technology can mitigate these frictions by establishing a standard and trusted database for real-estate transactions and payments. Taking this a step further, tokenizing ownership in these assets provides a new paradigm for fractional ownership and automated clearance.
When exploring the benefits of tokenized real-estate, the discussion almost always starts with the liquidity, or the lack thereof, in real-estate markets. Simply put, the argument states that divisible ownership of a largely illiquid asset allows for smaller investments to comprise of the final component of a larger offering.
In the case of $100M, $10M minimum investment based raise, 90% may be easily accessible from hedge funds and family offices abroad. Rather than relying on a select few accredited investors willing and able to meet the $10M minimum investment quota, tokenized real-estate allows for check sizes to be decreased to a much more digestible 5–6 figure ask. This was perfectly illustrated by Harbor’s real-estate security token offering (STO) in which the minimum check size for ownership of The Hub in Southern California was only $21,000.
Private placements in the form of funds, private REITS, and discrete structured transactions in alternative asset classes such as real estate are generally deemed “held-to-maturity” by investors with no expectation of early redemption.
Secondary trading is infrequent, cumbersome, and typically trade at prices significantly below net asset value (NAV).
With proper structuring, tokenization addresses a broad spectrum of these issues, allowing for easy ownership transfer. Removing this transactional friction potentially enables liquid markets to emerge.
It’s important to recognize that while opening access to a broader audience is a step in the right direction towards enhanced liquidity, an issuer needs to ensure that there is still demand for the asset due to an attractive inherent valuation or feature set (described below) that makes an offering unique. Just because smaller investors could participate in a tokenized real-estate offering, true liquidity will not be present until the demand for the underlying asset is easily digestible and profitable to risk-averse parties.
Tokenized real-estate evolves upon existing legacy infrastructures. One of the biggest promises surrounding blockchain technology is the case for immutable data to be stored on a distributed ledger.
Commercial real estate (CRE) leasing transactions face a handful of challenges regarding inefficient property searches, lack of real-time data, time-consuming and paper-driven due diligence processes, complexities in managing leases agreements, property operations and cash flows.
In terms of property searches, CRE brokers, owners, and tenants paired with buyers and sellers tend to use multiple listing services (MLS) to access property data such as location, rent prices, property value, and features. As a result, the data is fragmented across multiple platforms and causes inefficiencies or discrepancies among the involved parties. Due to the lack of standardization, the accuracy and detail of the property data are entirely dependent on the listing broker’s preferences.
With a blockchain-based MLS, data can be distributed across a peer-to-peer network creating an increase in clarity and trust surrounding the property data.
Expanding on this idea of a blockchain-based MLS, the platform could leverage an incentive layer utilizing a real-estate based utility token, or grant rewards for conscious maintenance in the form of partial ownership over the property. As the process of tokenizing real-estate becomes commonplace, it’s safe to assume that first-movers may present a new paradigm for the control of these assets through the shared custody of digitized securities.
In today’s climate, property owners regularly run into complexities around the management of their lease agreements, operations, and cash flows. With the advent of smart contracts, key terms such as security deposits and lease payments can be recorded on the blockchain and autonomously executed at predetermined dates.
Depending on the terms of the lease agreement, smart contracts can initiate rent payments from the tenant to the owner without having to hand-deliver checks, use complicated payment portals and/or wait for a bank to process the transaction(s). Once the transaction has been finalized, the lessor can then transfer the possession of the property to the lessee with the agreement being recorded on a distributed ledger. Upon the completion of a lease, smart contracts can initiate and finalize the transfer of the security deposit back to the lessor.
Taking this a step further, the tokenization of the underlying asset(s) allows for the fractional ownership along with the ability to receive real-time dividends from the principals described above.
For example, a token owner of the St. Regent Aspen Resort can now automatically receive payments when the issuing entity records new gross profit. Rather than having to rely on quarterly dividends to be distributed by the parent company, smart contracts provide the functionality for dividends to be distributed at the point of purchase. Similarly, the same example would apply in the case of an apartment in which a token holder *could* receive a portion of each rent payment equal to their fractional ownership in the property as a whole.
The issuance of a tokenized piece of real estate can provide a transparent view of the capitalization of the underlying asset. For many real-estate investors, it’s common knowledge that an immense amount of frustration and uncertainty can arise from the inability to determine the holding structure on the underlying asset in question. A property held entirely by one debt-prone entity is much riskier than a property with twenty reputable, risk-averse parties.
By tokenizing a real-estate asset on a permissionless blockchain such as Ethereum, it is now possible to determine each and every entity holding an asset along with their respective stake.
*It’s important to note that in this specific case, we are making the assumption that the underlying asset is being issued on a permissionless blockchain such as Ethereum, but realistically speaking, any tokenized asset will provide transparency to the permissioned actors regardless of the underlying protocol being used.
In our last example, the benefit of a blockchain implementation revolves around two parties, the lessee and lessor. However, real estate transactions typically involve numerous entities which must record, track, and execute payments and transactions on a regular basis. In CRE, not only must the cash flows be seen by the real estate owner, but also by auditors who must prepare and review financial statements, banks who need insight on financing decisions, regulatory bodies to ensure compliance and appraisers to accurately value properties. With all of these entities looking for insights and data, real estate companies spend a significant amount of capital on accounting, compliance and cash flow management needs.
With the advent of blockchain technology and the proliferation of smart contracts, all parties can receive real-time, immutable data surrounding the payments and transactions on a distributed ledger.
As the tokenization of real-estate begins to evolve over the coming years, it’s important to recognize that we are still in the early stages of both development and adoption of these practices. The benefits highlighted above are a great high-level argument for why the tokenization of a real-estate asset may be beneficial to some parties.
As we continue to explore this landscape with future clients, we hope to provide feedback on the reception we are receiving surrounding the viability of these protocols and whether or not major traditional real-estate entities would ever consider adopting a tokenized standard.
Until then, stay tuned for the launch of dozens of security-based real-estate protocols and an even more significant amount of arguments surrounding whether or not they are genuinely adding value to the real-estate landscape as a whole. We think it is!
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Fitzner Blockchain Consulting is a leading management consulting firm that specializes in blockchain-based systems and their design